When Trading in Bitcoin, Keep the Tax Man in Mind

Bitcoin may grab headlines when it skyrockets in value, as it did much of last year, or when it plunges precipitously, as it has this week.

But the virtual currency has a reputation for providing a sense of anonymity to those who own it.

That anonymity doesn’t extend to the tax authorities, however.

Come April, people who have bought and sold Bitcoin — or any of the other digital currencies that have quickly sprouted across the web — will be expected to report any profits on their federal tax returns.

Considering Bitcoin’s jump of more than 1,500 percent last year, there are probably many people who logged gains or losses for the first time, as people rushed in with the irrational exuberance of the early dot-com days.

But how much tax you owe will depend on how and when you acquired the digital currency — which, in fact, isn’t treated as a currency at all. Instead, for tax purposes, the Internal Revenue Service views Bitcoin and its cryptocoin cousins as property.

For the most part, that means Bitcoin and other digital currencies will be treated similarly to an investment like stocks — but not always. Given the speed at which these currencies have caught on — Bitcoin was released only in 2009 — regulators haven’t quite kept pace. The I.R.S. issued basic guidelines in 2014 for digital currencies, but tax experts say some of the rules are subject to interpretation.

Other aspects, however, are quite clear. “Every time you transfer a cryptocurrency, you might trigger a gain and pay a tax,” said Selva Ozelli, a tax lawyer and accountant who has recently written about the tax implications of virtual currencies.

In late 2016, the I.R.S. made it clear that it was searching for cryptocurrency tax evaders: The agency sent a broad request to Coinbase, the largest Bitcoin exchange in the United States, requesting records for all customers who bought digital currency from the company from 2013 to 2015. Coinbase balked, but a court ruled that it must provide the records of roughly 14,000 customers, fewer than 1 percent of its patrons, who made transactions involving more than $20,000 of virtual currencies.

“If you play audit roulette, you are a fool,” said Daniel Morris, an accountant with expertise in digital currencies. “If you made a single trade or more, report it.”

Here are some basics about the tax implications of virtual currency:

I sold some Bitcoin last year. What do I need to do?

If you are holding Bitcoin as an investment, any gains or losses on the sale are treated as capital assets, like a stock or bond. The gain or loss is calculated against the market value of the currency when you acquired it (known as your basis).

If you held the currency for more than a year, you qualify for the less onerous long-term capital gains rates (generally 0, 15 or 20 percent). Short-term gains, from digital coins held for a year or less, are taxed as ordinary income.

As on the stock market, losses can be used to offset capital gains, subject to certain rules, and losses that are not used to offset gains can be deducted — up to $3,000 — from other kinds of income. Unused losses can be carried over to future years.

I bought a computer (or another product or service) using Bitcoin. Are there tax implications?

The short answer: Yes.

More than 100,000 merchants worldwide accept Bitcoin, including big companies like Microsoft and Expedia, according to a 2017 report from Wolters Kluwer Tax & Accounting, a tax software and analysis firm.

So, for instance, if you bought Bitcoin as an investment in late 2013, when it was trading at around $1,000, and used it to buy a car when the currency was trading at $18,000, you would have a long-term capital gain of $17,000, explained Ryan Losi, an accountant and executive vice president at Piascik, a tax firm.

Likewise, if you suffer a loss, that should also be reported on your tax return.

I’ve successfully ‘mined’ Bitcoins. Now what?

All Bitcoin transactions are recorded in a public ledger, which is maintained by a decentralized network of computers. Mining refers to the process in which new Bitcoins are created and then awarded to the computers that are the first to process these transactions coming onto the network. The people whose computers do this most quickly collect a fresh helping of Bitcoins.

These virtual miners must report the fair market value of the currency (on the day they received it) as gross income. Miners are also required to pay self-employment tax — that is, Social Security and Medicare taxes — if the mining “constitutes a trade or business,” according to the I.R.S.

I was paid in Bitcoin. Are there any special tax consequences?

Receiving wages from an employer in a virtual currency is like being paid in dollars: It is taxable to the employee, must be reported by the employer on a Form W-2 and is subject to federal income tax withholding, according to Wolters Kluwer.

Independent contractors paid in digital currency must also treat that as gross income and pay self-employment taxes.

What if I paid someone else in Bitcoin for their services?

When you pay an independent worker (not on your payroll) in excess of $600 for services performed for your “trade or business,” that should be reported to the I.R.S. and the person receiving the payment (generally using Form 1099-MISC). The same rules apply when an individual is paid in virtual currency with an equivalent value.

Can I reduce my tax bill by donating my cryptocoins?

Potentially. Only people who itemize their tax returns can deduct their charitable contributions. But under the new tax code, far fewer people are likely to itemize starting with their 2018 return.

For those who still itemize, it may be possible to directly donate their Bitcoin (or Ether, etc.), just as they can directly donate, say, highly appreciated stock — as long as the charity accepts it.

For example, Fidelity Charitable, a donor-advised fund, allows people to give money, take a tax deduction in the same year, and then invest and allocate the money to select charities over time. Fidelity Charitable collected roughly $22 million in Bitcoin donations through early December; it works with Coinbase, the exchange, to immediately turn the Bitcoin or Ether into cash, which is then invested as its donor wishes.

Will I receive any tax forms from my exchange? Do I have to track my own transactions?

Generally speaking, brokers and exchanges are not yet required to report cryptocurrency transactions to the I.R.S., as they do when you sell a stock at a profit or loss (and you receive a 1099-B or a 1099-DIV for a mutual fund).

But you will need to keep track of every move you make. Coinbase, for example, refers you to your account transaction history for records to compute your gains and losses; it also provides customers a “cost basis for taxes” report.

One of the most common questions TurboTax received from its users was how and where to report their virtual currency transactions, according to Lisa Greene-Lewis, an accountant with TurboTax. (Use Form 8949 to add it all up, and report it on Schedule D, along with any other capital gains.)

Does the new tax bill change any of this?

The bill eliminated what some interpreted to be a tax break for virtual currency holders. Under the old rules, some cryptocoin investors applied a legal maneuver often used with real estate investments to defer their capital gains. Under what is called a 1031 exchange, taxpayers can sell one property and defer taxes as long as the proceeds were reinvested in a similar, or “like-kind,” property and met certain requirements.

The I.R.S. didn’t say this strategy could be used with virtual currencies, but some tax experts argued that it was a reasonable — albeit debatable — interpretation since the coins were considered property. Now that the tax legislation limits the use of 1031 exchanges to real estate, they no longer apply, accountants said.